Pension funds’s illiquid assets allocation under liquidity and capital requirements
This paper empirically assesses the impact of liquidity and capital requirements on the strategic allocation of defined benefit pension funds to illiquid asset classes using unique and unbiased data. Liquidity requirements result from short-term
pension payments and margin calls on derivative positions, while capital requirements are enforced by the regulator to absorb unexpected losses. The liability duration and interest rate/currency risk hedging both affect the allocation to illiquid assets through these requirements. Consistent with our theoretical framework, we document how these liquidity and capital requirements affect the allocation to illiquid assets. For instance, pension funds with low liability duration have high liquidity requirements resulting in low illiquid assets allocations. On the other hand, pension fund with high liability duration have low liquidity requirements, but high capital requirements as a result of interest rate risk, limiting opportunities to invest in illiquid assets.